Contemporary Issues of Public Finance in Taiwan

1. Contemporary Issues of Public Finance in Taiwan Vance Kuang-Ta Lo Associate Professor Department of Public Finance National Chengchi University March 24, 2017

2. Outlines • Part I: • Global Economic Situation and Outlook • Current Domestic Economic Situation • Prospects For 2017 • Part II: • Taiwan’s Current Fiscal Challenges • Part III: • Why Do We Need a Government? • Examples • Remedies

3. Part I

4. Global Economic Situation and Outlook This part was prepared by the Department of Economic Development of the National Development Council (NDC), TAIWAN’S ECONOMIC SITUATION AND OUTLOOK, Quarterly updates can be found on the NDC’s website at http://www.ndc.gov.tw/en/News9_1.aspx?n=98DD6A0140672599&sms=470111FB454E4B6D

5. Global GDP Growth Set to Rise in 2017 • In 2016, global economic growth is forecast to be lower than in 2015, mainly due to a weaker-than-expected economic recovery in the U.S., tepid growth rates in the Eurozone and Japan, together with a rebalancing in Mainland China. • According to the OECD’s Economic Outlook released in November, if the incoming US Administration implements a fiscal initiative that boosts domestic investment and consumption, global growth could increase in the next two years. However, downside risks remains for the global economy due to the rising tide of populism and protectionism and the uncertainty regarding the course of Brexit. World Economic Outlook Projections unit：% • Note： 1. The values in parentheses represent the previous forecast. • 2015 growth rates are from officialstatistics. • In the OECD’s forecast, “advanced economies” represent OECD countries, while “emerging markets” represents Nnon-OECD countries. • Source：1. OECD, OECD Economic Outlook, Nov. 28,2016 5 5 2. IHS Global Insight Inc., World Overview, Dec. 15,2016

6. Growth Momentum to Stabilize in the US • US real GDP increased at an annual rate of 3.2% in the third quarter of 2016, higher than the predicted estimate of 2.9%, and primarily reflected an upward revision of personal consumption expenditures. • The unemployment rate dropped to 4.6% in November 2016, while CPI inflation rate rose to 1.6% in October, hitting highest level since November 2014. In addition, manufacture PMI showed expansion for the third consecutive month in November. Fed has increased the key policy interest rate by 25 basis points in December to a target range of 0.5-0.75%. • The fiscal program set out by the Trump administration, expanding infrastructure spending, easing financial regulation, and tax cuts, may boost business investment but could also increase the fiscal deficit, interest rates and the value of the US dollar, which will weigh on US long-term economic growth. Manufacturing PMI % 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 quarter Q1 Q2 year 2014 54% 53.2 Real GDP Growth Rate 51.5 52 51.9 50 49.4 48 46 month year 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 1011 2015 2016 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2015 2016 Note：PMI is between 0%~100%. If higher than 50%, it means manufacturing is in the expansion phase. If lower than 50%, it means it is in the contraction phase. Source：ISM, Dec. 1, 2016 6 Source：U.S. Department of Commerce, Nov. 29,2016

7. Eurozone Gradually Pulls Out of Deflation • Eurozone real GDP increased by 0.3% in Q3 of 2016, showing the economy remain stable. In addition, the manufacturing PMI rose to 53.7% in November 2016, hitting its highest level since January 2014. • Inflation in the Eurozone was 0.6% in November 2016, the highest annual rate since April 2014, while the Core CPI (excluding energy, food, alcohol & tobacco) was 0.8%, still below the ECB target of 2%. There is concern that the ECB will extend its quantitative easing program beyond March 2017. CPI Inflation Real GDP Growth Rate % % 51.7 month year 2015 2016 Note： PMI is between 0%~100%. If higher than 50%, it means manufacturing is in the expansion phase. If lower than 50%, it means it is in the contraction phase. Source：Markit, Dec. 1, 2016 quarter year 2015 2016 7 7 Source： EuroStat, Dec. 6,2016

8. Japan’s Economy Remains Weak • Japan’s real GDP increased at an annual rate of 1.3% in Q3, compared with a preliminary reading that showed 2.2% expansion, mainly due to a drop in capital spending and in private inventories. However, Manufacturing PMI showed expansion for the third consecutive month in November 2016, supported by the recovery of foreign demand. • The Core CPI annual inflation rate was -0.4% in October 2016, remaining negative for the eighth consecutive month. BOJ indicated a possible delay until 2018 in the achievement of the 2% inflation target. However, the recent rise in the dollar has reversed some of the damaging appreciation of the yen in the past year and could help to pull the Japanese economy out of deflation and boost Japanese exports. Manufacturing PMI CPI Annual Inflation % % month year month year 2015 2015 2016 2016 Note：Core CPI less fresh food. Source：Statistics Bureau of Ministry of Internal Affairs and Communications, Nov. 25, 2016 Note： PMI is between 0%~100%. If higher than 50%, it means manufacturing is in the expansion phase. If lower than 50%, it means it is in the contraction phase. Source：Markit, Dec. 1, 2016 8

9. Mainland China’s Economy Shows Signs ofStabilization • Mainland China’s economic growth is being supported by stimulus, as third- quarter GDP growth rate was 6.7% and PMI rose to 51.7% in November 2016. In addition, exports rose 0.1% in November, ending seven consecutive months of declines. • According to an IMF report released on August 11th, Mainland China’s continuing reliance on policy-driven stimulus and credit would support near- term growth, but risks could rise as productivity weakens and credit and debt keep building up. Global Insights also indicated that Mainland China’s overcapacity and elevated debt levels are major worries for its economic growth. Growth Rate of Main Economic Indicators Manufacturing PMI % 16 (% change) 財新中國 官方 CaixinChina National Bureau ofStatistics Retail Sales % 51.7 10.8 52 12 8.3 51 Fixed Asset Investment 8 9 50 6.2 4 49 Industrial Production 48 0 47 1~2 3 4 5 6 7 8 9 10 11 12 1~2 3 4 5 6 7 8 9 10 11 2016 2015 Source：National Bureau of Statistics in Mainland China, Caixin China , Dec. 1, 2016 Note: The growth rate of fixed asset investment is the cumulative growth rate. Source：National Bureau of Statistics in Mainland China, Dec. , 2016 9

10. Current Domestic Economic Situation

11. Foreign Trade Momentum Increases Moderately • Total exports increased by 12.1% in November 2016, mainlydue to the strong demand for semiconductors, while Taiwan’s semiconductor manufacturing has benefited from its advanced technology and the rising global demand for mobile devices. • Imports increased by 3.0% over the previous year, with parts of electronic product, the main contributors to the increase. • Exports for the January through November 2016 period were down 3.1% compared with the same period a year ago. y/y,% The Gross Value and Growth Rate of Exports and Imports US$,billion 60 30 Gross value of exports (left scale) Gross value of imports (left scale) Export growth (right scale) Import growth (right scale) 50 20 40 10 30 0 20 -10 10 -20 0 -30 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 2014 2015 2016 9 1011 Note: Since FY2016, the general trade system applied for compilation of external trade statistics and the historical data has been revised to FY2001. Source: Ministry of Finance, Dec. 2016 11

12. Industrial Production Increases Slightly • The Industrial Production Index (IPI) posted an annual increase of 3.70% in October 2016, mainly due to the expansion of semiconductor production driven by strong demand for mobile devices. • Manufacturing output, which makes up more than 90% of the IPI, rose by 5.67% year-on-year in October. The increase in manufacturing output came largely from increased production of electronic parts and components, plus base metal. The Growth Rate of the Industrial Production Index y/y,% 20 10 0 -10 1 4 7 101 4 7 10 1 4 7 10 2014 Source: Ministry of Economic Affairs, Nov.2016 2015 2016 12

13. Retail Trade Solid • In October 2016, wholesale trade increased by 0.4%, benefited from rising demand for the electronic parts and components driven by the launch of new smartphones products. • Retail trade rose by 0.4%, driven mostly by general merchandise, automobile and motorcycle sales. • Food and beverage services increased by 6.8% in October 2016. Growth Rate of Wholesale, Retail Trade, and Food Services y/y,% 15 Wholesale Trade Retail Trade Food and BeverageServices 10 6.8 5 0.4 0.4 0 -5 -10 -15 2 3 4 5 6 7 8 9 10 1112 1 2 3 4 5 6 7 8 9 10 11 12 2015 1 2 3 4 5 6 7 8 9 10 2016 13 Source: Ministry of Economic Affairs, Nov.2016

14. Employment Remains Steady • The unemployment rate fell from 3.99% in September to 3.95% in October 2016. The seasonally adjusted unemployment rate was 3.90%. • Thelaborforceparticipationraterosefrom58.79%inSeptemberto58.81% in October, up 0.08 percentage points compared with a year earlier. Unemployment Rate and Labor Force Participation Rate % % 58.81 6.0 5.5 5.0 4.5 59.0 58.5 58.0 3.95 4.0 57.5 57.0 56.5 56.0 Labor force participation rate (leftscale) Unemployment rate (rightscale) 3.5 3.0 2 4 6 8 1012 2013 2 4 6 8 1012 2014 2 4 6 8 1012 2 4 6 8 10 2015 2016 Source: DGBAS, Nov. 2016 14

15. Prices Up Slightly • Taiwan’s CPI in November 2016 moved up 1.97% compared with the same month of the previous year, mainly due to the 37.53% increase in the vegetable index. In addition, the price of fruit also rose 9.56%, and that of food eaten outside the home increased by 1.19%. Core prices (excluding fruit, vegetable and energy prices) increased by 0.84%. • The WPI decreased by 0.28% due to a decrease in the price of electronic parts and components, which went down 3.06%, and the price of water, electricity and gas, which moved down 9.73% CPI and WPI inflation y/y,% 4 1.97 0 -0.28 -4 CPI WPI -8 -12 1 3 5 7 9 11 2013 Source: DGBAS Nov.2016 1 3 5 7 9 1113579111357911 2014 2015 2016 15

16. Monitoring Indicators Showing “Green” Signal • In October 2016, the trend-adjusted leading index increased by 0.21% to 100.82, and the trend-adjusted coincident index was up by 1.09% to 104.05. • The total score of the monitoring indicators in October 2016 increased by one point to 24, flashing the “Green” signal for the fourth month. • Taiwan Business Indicators showed that the domestic economy continues its recovery. Trend-adjusted Leading and Coincident Indexes Monitoring Indicators 105 2016/10 104.05 Coincident Index 100 2016/10 100.82 Leading Index 95 10 1 2014 4 7 10 1 4 7 10 Source: NDC, Nov. 28,2016 16

17. Notes: Economic Indicators • An economic indicator is a statistic about an economic activity. Economic indicators allow analysis of economic performance and predictions of future performance. • Economic indicators can be classified into three categories according to their usual timing in relation to the business cycle: leading indicators, lagging indicators, and coincident indicators. • Leading indicators are indicators that usually, but not always, change before the economy as a whole changes. They are therefore useful as short-term predictors of the economy. Stock market returns are a leading indicator: the stock market usually begins to decline before the economy as a whole declines and usually begins to improve before the general economy begins to recover from a slump.

18. Lagging indicators are indicators that usually change after the economy as a whole does. Typically the lag is a few quarters of a year. The unemployment rate is a lagging indicator: employment tends to increase two or three quarters after an upturn in the general economy. • Coincident indicators change at approximately the same time as the whole economy, thereby providing information about the current state of the economy. There are many coincident economic indicators, such as Gross Domestic Product, industrial production, personal income and retail sales.

19. The Monitoring Indicators, also known as “business cycle indicators”, are a set of five colored signals similar to traffic lights, each representing a different state of the economy from recession to expansion. The appropriate indicator for each month is based on the most recent economic indices. Calculated by the National Development Council (NDC), the system serves as a reference for economic policymakers as well as businesses considering adjusting their operations and investment plans.

20. The economic indices used by the NDC are the M1B monetary aggregate (a composite of currency in circulation, checkable deposits, current deposits and demand deposits), direct and indirect finance, stock prices index, industrial production index, non-agricultural employment, customs-cleared exports, imports of machinery and electrical equipment, manufacturing sales, and sales index of trade and food services. • Each component is assigned one to five points depending on its strength. The sum of these scores is the composite score, which determines the color signal of the monthly Monitoring Indicator.

22. A blue light, given for a score of 16 or below, represents recession; • A green light (23-31) means stability • A red light (38 and above) demonstrates expansion. • The intermediate lights, yellow-blue (17-22) and yellow-red (32-37), indicate a transition between business cycles and the necessity of close scrutiny.

24. Prospects for 2017

25. The Economy To Show Moderate Growth • According to the latest estimate in November 2016, Taiwan’s GDP growth rate in 2016is forecast at 1.35%, up 0.13 percentage points from August 2016’s forecast, mainly due to better-than-expected performances of exports, private consumption, and fixed investment. • In 2017, GDP is expected to rise by 1.87%, higher than in 2016, reflecting that Taiwan’s economy will proceed at a moderate pace. Quarterly GDP Growth Rate % Economic Outlook Contributions to GDPgrowth GDP Growth Rate GDP Growth Rate(%) rate (percentagepoints) 6.00 6 4.02 3.80 4.00 4 2.20 1.87 2.06 1.35 2.00 2 0.72 0.00 0 -2.00 -2 Contributions of domestic demand 2011 2012 2013 Contributions of net foreign demand 2015 2016 f 2017 f -4.00 year -4 2014 Source: DGBAS, Nov. 2016 18

26. Exports Expected to Revive in 2017 • Thanks to a global semiconductor industry rebound and rising commodity prices, Taiwan’s real goods exports and services exports are projected to grow by 1.54% in 2016. • For 2017, IMF has forecast that world trade will grow by 3.8%, higher than the 2.3% of 2016. In addition, semiconductor manufacturers’ continued investment in advanced production capacity, and the rising demand for emerging applications for the Internet of Things (IOT) and automotive electronics, will both help boost Taiwan’s exports. However, increased global trade protectionism and the expanding local supply chain in Mainland China may restrain Taiwan’s export momentum. Real goods and services exports are projected to grow by 3.83% in 2017, while goods and services imports are forecast to rise by 3.85%. The Growth Rate of Nominal Goods Exports (y/y) 2016 growth rate: -2.85% The Growth Rate of Real Goods and Service Exports and Imports % % 8 6 4 2 0 - - 108.27 6.87 7.17 Goods and services imports 5.86 4.07 5 1.22 0.11 3.85 5.67 3.50 0 2.47 3.83 1.19 -5 3.4 0.41 -6.23 2017 growth rate: 4.95% 1.54 -10 -0.34 Goods and services exports 2013 2014 2015 2 4 -12.11 Q1 -15 quarter -1.78 Q2 Q3 Q4 Q1 Q2 Q3 Q4 year 2012 2016f 2017f 2016f 2017f 19 Source: DGBAS, Nov.2016

27. Private Consumption Growth Expected to Slow • The double-digit growth in the number of people in Taiwan traveling abroad in the first three quarters and the government’s tax reduction policy for the car market boosted private consumption. However, limited salary increments and employment may weaken private consumption growth momentum. Taking into account the above factors, private consumption is projected to rise by 1.94% in 2016. • In 2017, with gradual recovery of domestic economy, private consumption is expected to maintain its modest path. The growth rate of private consumption is projected to be 1.74% The Growth Rate of Private Consumption 2016 growth rate: 1.94% 2017 growth rate: 1.74% 2015 growth rate: 2.68% % quarter Source: DGBAS, Nov. 2016 20

28. Domestic Investment Expected to Slightly Increase • Semiconductor manufacturers continued invest in advanced production capacity to keep the lead in manufacturing and exploit opportunities of intelligent applications, such as the Internet-of-things and Internet-of-vehicles, together with airline companies increased purchases of aircraft, will both help boost private investment. However, tepid construction investment affected by the slowdown in the housing market will be a restraining factor. Taking into account the above factors, private fixed investment isprojected to increase by 2.00% in 2017, higher than 1.88% in 2016. • With the government accelerating budget implementation, government fixed investment and public enterprise fixed investment are expected to rise by 1.19% and 1.73% in 2017 respectively. The Growth Rate of Each Component The Growth Rate of Fixed Investment (y/y) of Fixed Investment % 2016 growth rate: 1.92% 2017 growth rate: 1.88% % 8.00 6.00 4.04 3.35 4.00 2.00 2.80 2.42 1.43 1.03 0.16 0.00 -2.00 quarter -0.12 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2016f 2017f 1 Source: DGBAS, Nov.2016

29. Inflationto Remain Stable • In 2016, with international oil and raw material prices expected to be lower than the previous year, the WPI is forecast to decrease by 3.39% in the year. In 2017, with gradually recovering global economy, WPI is expected to increase by 0.85%. • The CPI is forecast to increase by 1.31% this year, mainly due to rising food prices affected by the cold front early this year and the summer typhoons. In 2017, CPI is projected to rise by 0.75%. WPI and CPI inflation % 4 2 0 -2 -4 -6 -8 -10 CPI 1.93 1.31 1.20 0.79 0.75 -0.31 -1.16 0.85 -2.43 -0.57 -3.39 WPI -8.84 20122013 2014 2015 2016f 2017f year Source: DGBAS, Nov.2016 22

30. Forecasts for Taiwan’s Economy DGBAS = Directorate-General of Budget, Accounting and Statistics, ROC (Taiwan) ; CIER = Chung-Hua Institution for Economic Research, Taipei ; TRI = Taiwan Research Institute ; TIER = Taiwan Institute of Economic Research, Taipei ; Yuanta-Polaris = Yuanta-Polaris Research Institute ; IEAS = Institute of Economics, Academia Sinica ; ADB = Asian Development Bank ; IMF = International Monetary Fund. [ ] indicates the value of previous forecasts 23 P = preliminary; f =forecast

31. Part II

32. Taiwan’s Current Fiscal Challenges

33. Our Current Fiscal Situation • From 2008 to 2014, the annual expenditure is usually greater than the annual revenue, and the budget fiscal deficit of 2014 was US$ 7.1 billion. • If we take the repayment of debt into consideration, the total fiscal deficit is US$ 9.2 billion, which should be balanced mainly by the issuance of debt.

34. However, the outstanding debt in Taiwan has shown an upward trend. The ratio of outstanding debt to the average nominal GDP for the previous three fiscal years increased from 30.7% in 2008, 37.5% in 2013, and 38.1% in 2014, which is approaching to the legal debt ceiling of 40.6%. • Therefore, it is quite difficult to balance our fiscal deficit by the issuance of debt. If the government does not adopt any reform measure, we may face fiscal difficulty in few years.

35. Gradual Increase in Statutory Expenditure • The statutory expenditures have also shown an upward trend from 2008 to 2014. The overall figures also show that our expenditures are quite rigid and inflexible.

36. Increase in Expenditures due to Change in Major Policies • Moreover, the structure of the population is changing. For example, a low fertility and an aging population are having an impact on related policies. In addition, we are planning to implement the major policies of “12-Year National Fundamental Education” and “Long-Term Care” among others. And, thus, we expect that the related expenditures will be on the increase.

37. Revenue Structure and Tax Burden Ratio • As for our revenue structure, tax revenue composes the main part of the revenues. The ratio of tax revenue to total revenues was 70.4﹪in 2013. However, our tax burden ratio was only 12.6% in the same year. This means that there is still room for raising tax revenue. Revenue Structure Tax Burden Ratio

38. Remarks (1/5) We think there are three main challenges to Taiwan’s fiscal account, which lead to concern over continued fiscal deficits and rising government debt level. (1) Sub-trend GDP growth • With its high export dependency, Taiwan’s economic growth is negatively affected since the onset of the global credit crisis in 2008. • Weakened consumption demand in the developed markets have been negatively affecting Taiwan’s export sector and the overall economy.

39. Remarks (2/5) • The growth slowdown has impacted the fiscal accounts in two ways: • First, it has slowed the growth in fiscal revenue. Taiwan’s general government net revenue growth has slowed to 0.8% per year from 2008 to now, compared to 3.8% per year from 2004 to 2007. • Second, it has expedited the growth in fiscal expenditure. Because of the slowdown in growth, the government has to allocate more spending on infrastructure projects to boost the economy. As a result, net general government expenditure growth has accelerated to 3.5% per year between 2008 and now, up from 0.9% per year between 2004 and 2007.

40. Remarks (3/5) (2) Low tax burden • Taiwan’s tax revenue represented only about 12.3% of GDP in 2014, which is much lower than other countries.

41. Remarks (4/5) (3) An aging population • An aging population is the most serious challenge to Taiwan’s fiscal condition in the coming years. • According to the Council for Economic Planning and Development (CEPD), Taiwan’s population is expected to rapidly age starting from 2013 onwards. • The percentage of old-age population (defined as age 65 and above) is expected to rise from 11.5% of the total population in 2013 to 14.6% in 2018, and continue rising in subsequent years. • At the same time, the working-age population (defined as age 15 to 64), is expected to shrink from 74% of total population in 2013 to 72.7% in 2018. • The old-age dependency ratio is hence expected to drop from around 6.4 in 2013 to 4.9 in 2018, and continue deteriorating.

42. Remarks (5/5) • The aging of Taiwan’s population is structural, which makes it very difficult to alter by the government over the medium term. • This should have serious implications on the government’s tax revenue, and more importantly, on the government’s social security and pension-related spending. • In 2011, social security and pension expenditure represented 5.5% of GDP and 28.7% of the general government net expenditure. • The ratios are projected to rise further to over 7% of GDP and 33% of government expenditure in 2018 as the population ages, assuming no effective reform measures are introduced to avert the trend.

43. Based on the definition from World Health Organization (WHO): 7% : Aging 14%: Aged 20%: Super-Aged the percentage of elders over 65 years old ＞

44. Total,%ofpopulation,2014

45. According the figure on next page (Figure 8), the share of Aged 65 and above has an upward trend during 1980 to 2060. • Taiwan has been considered as an aging country since 1993. • Taiwan is further forecast to become an aged society and super-aged society in 2018 and 2025, respectively. • As pointed out by Hsueh and Wang (2008), the aging rates will grow faster in Taiwan than in most of the developed regions in the future. • It will take only 25 years for the aged portion of the Taiwan population to rise from 7% to 14%, second only to Japan (taking only 24 years) in terms of the shortest time span.

47. Taiwan’s population aging is the result of low death rate due to advance medical technology, low birth rate, and prolonged life expectancy. • Figure 9 shows the life expectancy of all Taiwanese, male and female people.

49. Significant Decline in Fertility • Figure 10 presents a time trend of general fertility rate (GFR, hereafter) and total fertility rate (TFR, hereafter) of Taiwan during 1981-2014. • TFR has been lower than replacementlevelof2.1 since 1985. • In 1985, the TFR was 1.88. It was even lower than 1 in 2010, only 0.895.

50. General fertility rate (GFR) • the number of births in a year divided by the number of women aged 15–44, times 1000. It focuses on the potential mothers only, and takes the age distribution into account. • Total fertility rate (TFR) • the total number of children a woman would bear during her lifetime if she were to experience the prevailing age-specific fertility rates of women. TFR equals the sum for all age groups of 5 times each ASFR rate. Age Specific Fertility Rate (ASFR) = (Number of births to women in age group i / Number of women in age group i) x 1000 LetB=Numberofbirth LetW15-44=Numberofwomenofreproductiveages Total Fertility Rate (TFR) = (The sum of the ASFRx The number of years in each age group) / 1000